I have struggled with the insights for this book for almost twenty years. While all the ideas are based on the current body of knowledge of the Theory of Constraints (TOC), they extend its applicability and usefulness. TOC already has challenged the use of cost-per-unit and local performance measurements that have a huge negative impact on managerial decisions today. Expanding the already well-advanced TOC BOK requires special care and self-checking every part in the chain of logic. When Henry Camp and Rocco Surace joined me in the writing, including outlining the necessary direction of solution and adding their own perspectives, it was a huge and absolutely necessary help.
There is a basic difference between a book and a blog, as they serve different needs. Short articles in the blog are focused on one insight and if the reader sees value in the insight, then more efforts are required to develop the generic insight into a practical process. A book should encompass the development of several new insights and integrate them into a clear focused message that is valid both theoretically and practically.
What is the particular need for Throughput Economics?
We claim that good management decisions must be analyzed and supported in a very different way than is customary today. Managers have huge responsibilities on their shoulders and they deserve a better method to consider the relevant and available information to generate the best possible picture of might happen when any significant decision is undertaken.
The simple fact is that the current (and long established) methods of cost accounting distort the decision-making process by presenting a flawed picture of expected profits or losses resulting from the decision. Managers might intuitively sense the impact of the considered decision on the bottom-line and they are also aware that the quality of their intuition is questionable. Fear of unjust criticism, once the results become clear, is another factor that impels managers to utilize well-accepted tools, even if they feel those very tools are flawed. In order to change the way managers are making decisions there must be a comprehensive alternative procedure that is demonstrably superior.
While the insights of TOC contributed much to clarify the flaws of cost accounting tools for decision making, pinpointing the underlying flawed paradigm behind the concept of cost-per-unit, could be quite beneficial. The core mistaken assumption is treating the cost of maintaining capacity as if it were linear. This is just wrong because capacity of most resources can only be purchased by certain amounts – in chunks, if you will. For instance, if you are looking for space for your office you might have a few alternatives each with its own specific square footage. Eventually, you choose the most convenient one that has more space than you actually need. It is up to you to treat the extra space as a “waste” or as an opportunity that, when triggered by new market opportunities, you already have the space you will need. This benefit is offset by paying more for a bigger space in the meantime. The point is that it is unrealistic to expect to be able to purchase exactly the capacity required for the changing level of activity in your business.
The fact that most resources have excess capacity means that consuming the surplus capacity generates no additional cost. However, once the practical limit of the available capacity is reached, then any optional capacity increase is typically quite expensive and the quantities in which more capacity can be quickly purchased are normally subject to certain minimums. This characteristic of buying capacity is what makes it non-linear. The rub is: to know whether an additional consumption of capacity required for a new opportunity is ‘free’ or expensive, you must consider all your capacity requirements – the proposed new needs on top of all current activities. In other words, a global calculation has to be made to estimate the actual impact of implementing a new decision on total operating expenses.
The most important decisions undertaken by any organization concern sales or capacity. Sales are the key factor for income and maintaining capacity is the crux of expenses that enable the organization to provide what it sells. It was an ingenious idea of Goldratt to look for two distinct information categories that impact any new decision concerning sales or capacity: Throughput (T) on one hand and Operating Expenses (OE) (and Investment (I)) on the other. T focuses on the added-value generated by sales. OE describes the cost of maintaining the required capacity. While changes in T usually behave in a linear fashion, the true impact of a new move on OE, the expenses for maintaining capacity, must consider the non-linear behavior of OE. This non-linear behavior is often a big surprise to the managerial intuition of whether the proposed move is positive or negative.
What clearly comes out from cost’s non-linear nature is the requirement to analyze any new potential deal, not just by its own specific details and definitely not by any ‘per-unit’ artificial measurement, but by simulating the new deal as an addition to the load of the current activity of the whole organization and then checking the impact on ∆T, ∆I and ∆OE.
Does this idea seem frightening because so many numbers and variables are involves? This is where the right kind of decision-support software can help us with the calculations. The principles are simple and straight-forward, but making a huge number of calculations should be delegated to a computer, as long as we human beings dictate the logic.
The power of our book is going into the details of such a broad idea, without losing its inherent simplicity. We present the holistic direction, while also covering enough details, to answer any doubt that might emerge.
In order to preserve the sensitive balance between the generic method and the tiny details, making sure nothing is lost in the process, we came up with several fictional cases where a management team needs to specifically analyze non-trivial new opportunities that could be great but might also be disastrous. Unless the analysis is done comprehensively outcomes are practically impossible to predict. I have already used these types of fictional cases to demonstrate the cause-and-effect behind generic principles in a previous book (Management Dilemmas). In this book, the detailed fictional cases are of special importance. Subsequent chapters refer to these cases and their intrinsic ideas in a more general way, explaining the processes from your perspective as an outside observer. Our objective was to lead you to see the insights from both perspectives: the practical case where managers have to deal with a specific non-trivial decision and the higher-level world of defining the global process for dealing with a variety of such decisions.
Amazon, of course, sells and ships the book: Throughput Economics by Eli Schragenheim, Henry Camp, and Rocco Surace
ISBN 978-0-367-03061-2 / Cat# 978-0-367-03061-2
If you need any help in purchasing the book write to me at: elischragenheim@gmail.com
Eli Schragenheim 